As Wall St. Polices Itself, Prosecutors Use Softer Approach

“Traditionally, a bank would tell the Department of Justice when an employee engaged in crimes, but what do you do when the bank itself is run by a criminal enterprise?” said Solomon L. Wisenberg, former chief of a Justice Department financial institutions fraud unit.Credit
Daniel Rosenbaum for The New York Times

As the financial storm brewed in the summer of 2008 and institutions feared for their survival, a bit of good news bubbled through large banks and the law firms that defend them.

Federal prosecutors officially adopted new guidelines about charging corporations with crimes — a softer approach that, longtime white-collar lawyers and former federal prosecutors say, helps explain the dearth of criminal cases despite a raft of inquiries into the financial crisis.

Though little noticed outside legal circles, the guidelines were welcomed by firms representing banks. The Justice Department’s directive, involving a process known as deferred prosecutions, signaled “an important step away from the more aggressive prosecutorial practices seen in some cases under their predecessors,” Sullivan & Cromwell, a prominent Wall Street law firm, told clients in a memo that September.

The guidelines left open a possibility other than guilty or not guilty, giving leniency often if companies investigated and reported their own wrongdoing. In return, the government could enter into agreements to delay or cancel the prosecution if the companies promised to change their behavior.

But this approach, critics maintain, runs the risk of letting companies off too easily.

“If you do not punish crimes, there’s really no reason they won’t happen again,” said Mary Ramirez, a professor at Washburn University School of Law and a former assistant United States attorney. “I worry and so do a lot of economists that we have created no disincentives for committing fraud or white-collar crime, in particular in the financial space.”

While “deferred prosecution agreements” were used before the financial crisis, the Justice Department made them an official alternative in 2008, according to the Sullivan & Cromwell note.

It is among a number of signs, white-collar crime experts say, that the government seems to be taking a gentler approach.

The Securities and Exchange Commission also added deferred prosecution as a tool last year and has embraced another alternative to litigation — reports that chronicle wrongdoing at institutions like Moody’s Investors Service, often without punishing anyone. The financial crisis cases brought by the S.E.C. — like a recent settlement with JPMorgan Chase for selling a mortgage security that soured — have rarely named executives as defendants.

Defending the department’s approach, Alisa Finelli, a spokeswoman, said deferred prosecution agreements require that corporations pay penalties and restitution, correct criminal conduct and “achieve these results without causing the loss of jobs, the loss of pensions and other significant negative consequences to innocent parties who played no role in the criminal conduct, were unaware of it or were unable to prevent it.”

The department began pulling back from a more aggressive pursuit of white-collar crime around 2005, say defense lawyers and former prosecutors, after the Supreme Court overturned a conviction it won against the accounting firm Arthur Andersen. That ended an era of brass-knuckle prosecutions related to fraud at companies like Enron.

Another example of this more cautious prosecutorial strategy: Government lawyers now go to companies earlier in an inquiry, and often tell companies to figure out whether improper activities occurred. Then those companies hire law firms to investigate and report back to the government. The practice was criticized last year when the Justice Department struck a settlement with Beazer Homes USA, a home builder accused of mortgage fraud.

This “outsourcing” of investigations — as some lawyers call it — has led to increased coziness between the government and companies, some critics say.

In banking, the collaboration is even stronger, dating to the mid-1990s when banks were asked to regularly report suspicious activities to the Treasury Department, an effort that aimed at relieving regulators of some of their enforcement loads. But it gave regulators a false assurance that banks would spot and report all wrongdoing, former investigators say. Moreover, companies are not as likely to come forward with evidence related to senior executives or to widespread patterns of misbehavior, some academics say.

Intended to make the most of the government’s limited investigative resources, the government’s cooperation with corporations and industry groups can work well and save money when business hums along as usual. But some veterans of government prosecutions question such collaboration in financial crisis cases, and contend they should have been pursued more aggressively.

“Traditionally, a bank would tell the Department of Justice when an employee engaged in crimes, but what do you do when the bank itself is run by a criminal enterprise?” said Solomon L. Wisenberg, former chief of the financial institutions fraud unit for the United States attorney in the Western District of Texas in the early 1990s. “You have to be able to investigate without just waiting for the bank to give you the referral. The people running the institutions are not going to come to the D.O.J. and tell them about themselves.”

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Beazer Homes ran afoul of the Department of Housing and Urban Development over its mortgage practices. But the Justice Department came to an agreement with the company, ending HUD's inquiry.Credit
Matt York/Associated Press

A Clash of Agencies

Beazer Homes, based in Charlotte, N.C., became one of the nation’s 10 largest home builders in the 2000s — in large part because of mortgage lending options that attracted buyers. But its mortgage business eventually attracted prosecutors, too.

In March 2007, the inspector general and officials of the Department of Housing and Urban Development began investigating claims that Beazer had engaged in mortgage fraud, causing losses to the Federal Housing Administration’s insurance fund that covered mortgages when buyers couldn’t pay.

Investigators found that Beazer had been offering a lower mortgage rate if buyers paid an extra fee, but then not giving them the lower rate. And it was enticing homeowners by offering down payment assistance, but not disclosing that it then raised the price of the house by the same amount.

The Beazer board’s audit committee hired the law firm of Alston & Bird to conduct an internal investigation. Documents supplied to Congress by HUD show that Justice Department officials advised HUD investigators not to interview borrowers or former Beazer employees until Alston & Bird completed its review.

In April 2009, justice officials notified HUD that a deferred prosecution agreement with Beazer had been reached — the sort of deal that Sullivan & Cromwell had celebrated in its client memo a year earlier — essentially shutting down the HUD investigation.

Beazer agreed to pay consumers and the government as much as $55 million under the deal. It also paid approximately that amount to Alston & Bird, investigators found. While a member of the justice team told HUD that criminal proceedings would be forthcoming against individuals at Beazer, the documents show, there has been only one indictment: of Michael T. Rand, the company’s former chief accounting officer, whose trial is to begin this fall.

A year after the settlement, Kenneth M. Donohue, the inspector general of HUD at the time, raised questions about its handling. He said he was disturbed by the interference by the Justice Department and its calls to stop pursuing Beazer executives so the deferred prosecution deal could be completed. “As a law enforcement official for over 40 years,” Mr. Donohue wrote in a letter to Eric H. Holder Jr., the attorney general, “I have never witnessed a like action in any of my varied dealings.”

In a recent interview, Mr. Donohue, now a senior adviser at the Reznick Group, an accounting firm in Bethesda, Md., said of the Justice Department: “The most important point of this whole thing is the fact that they threatened the HUD office of the inspector general that we would not be allowed to go forward with our investigation of executives if we didn’t agree to their settlement.”

David A. Brown, acting United States attorney on the case, said: “What we do is work cooperatively as a team in conducting these investigations. We don’t tell agencies to stand down when they are working as part of the team.” He said that the investigation was continuing, and that the Justice Department was proud of the deferred prosecution agreement and the restitution Beazer paid, which more than covered the losses of the Federal Housing Administration fund.

Beazer did not respond to an e-mail, and Alston & Bird did not return a call seeking comment.

Ms. Finelli, the department’s spokeswoman, said that deferred or nonprosecution agreements had led to charges against individuals in many cases; of the 20 companies she cited, three were financial companies. But none were cases related to the financial crisis.

Still, some lawyers applaud the closer relationship between the government and business. “Given the scanty resources that have been committed to corporate crime enforcement, I think the government’s leveraging of its prosecution power from corporations and their lawyers has been critically important,” said Daniel C. Richman, professor of law at Columbia and a former assistant United States attorney in New York.

But Professor Richman added that the government should have “a much more developed, funded and empowered S.E.C., Federal Reserve, E.P.A. and other agencies to do regulation, to do enforcement and feed cases where necessary to criminal prosecutors.”

Changing Course

The names have become synonymous with corporate wrongdoing — and forceful prosecution: Not just Enron, but also WorldCom, Tyco, Adelphia, Rite Aid and ImClone. In the early part of the last decade, senior executives at all these companies were convicted and imprisoned.

But by 2005, a debate was growing over aggressive prosecutions, as some business leaders had been criticizing the approach as perhaps too zealous.

That May, Justice Department officials met ahead of a session with a cross-agency group called the Corporate Fraud Task Force. It was weeks after Justice Department lawyers had presented to the Supreme Court their case against Arthur Andersen, which was seeking — successfully, it would turn out — to overturn its criminal fraud conviction in a prominent case.

In the meeting, the deputy attorney general at the time, James B. Comey, posed questions that surprised some attendees, according to two people there who asked to remain anonymous because they were not supposed to discuss private meetings.

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"They threatened the HUD office of the inspector general that we would not be allowed to go forward with our investigation of executives if we didn’t agree to their settlement," said Kenneth M. Donohue, former inspector general of HUD, speaking about the Justice Department.Credit
Daniel Rosenbaum for The New York Times

Was American business being hurt by the Justice Department’s investigations?, Mr. Comey asked, according to these two people, who said they thought the message had come from others. He cautioned colleagues to be responsible. “It was a total retrenchment,” one of the people said. “It was like we were going backwards.”

Mr. Comey said recently that he did not recall this conversation.

Around the same time, the Justice Department was developing instructions on dealing with companies under investigation — particularly companies that work with the government. It issued a memo in 2003 that gave companies more credit for cooperating than in the past. That message was reinforced in another memo in 2006.

As the first memo put it, “it is entirely proper in many investigations for a prosecutor to consider the corporation’s pre-indictment conduct, e.g., voluntary disclosure, cooperation, remediation or restitution, in determining whether to seek an indictment.”

During this period, the Justice Department increased the use of deferred prosecutions or even nonprosecution agreements.

Many well-known companies have benefited. In 2004, the American International Group, the giant insurer, paid $126 million when it entered a deferred prosecution agreement to settle investigations into claims that it had helped clients improperly burnish financial statements.

No such prosecution deals for large banks have yet arisen out of the financial crisis. Some bank analysts say they may be coming. The government may eventually strike one with Goldman Sachs, which it continues to investigate for its mortgage securities dealings, Brad Hintz, a securities analyst at Sanford C. Bernstein & Company, wrote recently. “If an alleged violation is identified during a Goldman investigation, we expect a reasoned response from the Justice Department,” he added.

Goldman Sachs declined to comment.

The S.E.C. can also file deferred prosecutions, and it sometimes issues reports about wrongdoing in lieu of litigation. It has been increasing the number of reports it files, and is considering issuing one about misleading accounting at Lehman Brothers, Bloomberg News has reported. The S.E.C. did something similar last year to resolve a credit ratings investigation of Moody’s Investors Service. The reports from the commission are intended to give companies guidance on appropriate practices.

Such results provide bragging rights among corporate defense lawyers, according to longtime observers of the legal system.

“The corporate crime defense bar has this down to a science,” said Russell Mokhiber, the editor of Corporate Crime Reporter, a publication that tracks prosecutions. “I interview them all the time, and they boast about how they’ve gamed the system.”

Industry Advantage

Even as companies cooperate with the government, they also work closely with one another, creating industrywide strategies in response to investigations. Legal representatives for Goldman Sachs, Morgan Stanley, JPMorgan Chase and others talk regularly about what they hear from the government, according to lawyers in the industry. They have long held these conversations — known as joint-defense calls — but given the increased cooperation of the government with companies, lawyers can exchange more information.

Goldman’s recent battle against the S.E.C. — in which it agreed to pay $550 million to settle claims that it had misled investors in a mortgage security it sold — was helpful to other banks, according to one lawyer who participates in these calls. On several occasions in 2009 and 2010, after Goldman and its law firm, Sullivan & Cromwell, visited the S.E.C., lawyers representing other banks received intelligence on the government’s areas of interest. The result has often been that banks walk into prosecutors’ offices well-prepared to rebut allegations.

One assistant United States attorney, who requested anonymity because he is not allowed to speak with the news media, said many inquiries had been tabled because banks had such good answers.

“They’ll hire a counsel who is experienced,” said the assistant attorney, who has direct knowledge of cases related to the financial crisis. “They often come in and make a presentation: ‘We’ve looked at this and this is how we see it.’ They’re often persuasive.”

Some defense lawyers say it is easier to make a persuasive case because prosecutors, having becoming more dependent on companies for investigative legwork, are less knowledgeable and thus less likely to counter with evidence they have uncovered.

The process, in the end, is cloaked, some critics say. The Justice Department does not disclose any details about its decision-making in specific cases, such as why it did not charge individuals at a company.

“We will not get an explanation of why there haven’t been prosecutions; at best, we will get a reference back to the Department of Justice manual that leaves the discretion to the prosecutors,” said Professor Ramirez of Washburn University. “The legal representatives will argue that since recoveries can be had by using civil measures, even private litigations, there’s no need to bring criminal measures. I disagree with that very much.”

A version of this article appears in print on July 8, 2011, on page A1 of the New York edition with the headline: Behind the Gentler Approach to Banks by U.S. Order Reprints|Today's Paper|Subscribe